New Economics Papers
on Banking
Issue of 2007‒08‒08
fourteen papers chosen by
Roberto J. Santillán–Salgado, EGADE-ITESM

  1. The Effect of Bank Competition on the Bank's Incentive to Collateralize By Hainz, Christa
  2. Credit Risk Transfer: To Sell or to Insure By James R. Thompson
  3. The economic impact of merger control - what is special about banking? By Elena Carletti; Philipp Hartmann; Steven Ongena
  4. Bank commercial loan fair value practices By John Tschirhart; James O'Brien; Michael Moise; Emily Yang
  5. Empirical analysis of corporate credit lines By Gabriel Jiménez; Jose A. Lopez; Jesús Saurina
  6. Has the credit derivatives swap market lowered the cost of corporate debt? By Adam B. Ashcraft; João A. C. Santos
  7. The Optimal Capital Structure of Banks: Balancing Deposit Insurance, Capital Requirements and Tax-Advantaged Debt By John P. Harding; Xiaozhing Liang; Stephen L. Ross
  8. Implications of Web 2.0 for financial institutions: Be a driver, not a passenger By Heng, Stefan; Meyer, Thomas; Stobbe, Antje
  9. Liquidity Shortages and Monetary Policy By Illing, Gerhard; Cao, Jin
  10. Federal Home Loan Bank advances and commercial bank portfolio composition By W. Scott Frame; Diana Hancock; Wayne Passmore
  11. Entrepreneurs' Gender and Financial Constraints : Evidence from International Data By Alexander Muravyev; Dorothea Schäfer; Oleksandr Talavera
  12. Evaluating the real effect of bank branching deregulation - comparing contiguous counties across U.S. state borders By Rocco R. Huang
  13. Public disclosure, risk, and performance at bank holding companies By Beverly Hirtle
  14. The performance of credit rating systems in the assessment of collateral used in Eurosystem monetary policy operations By François Coppens; Fernando González; Gerhard Winkler

  1. By: Hainz, Christa
    Abstract: It has been argued that competing banks make inefficiently frequent use of collateralization in situations where they are better able to evaluate a project's risk than entrepreneurs. We study the bank's choice between screening and collateralization in a model where banks do not have this superior screening skill. In particular, we study the effect of bank competition on this choice. We find that competing banks use collateral less often than a monopolistic bank because competition will intensify if both banks collateralize. Moreover, bank competition is welfare improving if collateralization is rather costly.
    Keywords: Collateralization; screening; incentives; bank competition
    JEL: D82 G21 K00
    Date: 2007–07
  2. By: James R. Thompson (Queen's University)
    Abstract: This paper analyzes credit risk transfer in banking. Specifically, we model loan sales and loan insurance (e.g. credit default swaps) as the two instruments of risk transfer. Recent empirical evidence suggests that the adverse selection problem is as relevant in loan insurance as it is in loan sales. Contrary to previous literature, this paper allows for informational asymmetries in both markets. We show how credit risk transfer can achieve optimal investment and minimize the social costs associated with excess risk taking by a bank. Furthermore, we find that no separation of loan types can occur in equilibrium. Our results show that a well capitalized bank will tend to use loan insurance regardless of loan quality in the presence of moral hazard and relationship banking costs of loan sales. Finally, we show that a poorly capitalized bank may be forced into the loan sales market, even in the presence of possibly significant relationship and moral hazard costs that can depress the selling price.
    Keywords: credit risk transfer, banking, loan sales, loan insurance, credit derivatives
    JEL: G21 G22 D82
    Date: 2007–06
  3. By: Elena Carletti (Center for Financial Studies, University of Frankfurt, Merton Str. 17-21, HPF 73, 60325 Frankfurt, Germany.); Philipp Hartmann (European Central Bank, DG Research, Kaiserstraße 29, 60311 Frankfurt, Germany.); Steven Ongena (Tilburg University, Department of Finance, P.O. Box 90153, 5000 LE Tilburg, The Netherlands.)
    Abstract: There is a long-standing debate about the special nature of banks. Based on a unique dataset of legislative changes in industrial countries, we identify events that strengthen competition policy, analyze their impact on banks and non-financial firms and explain the reactions observed with institutional features that distinguish banking from non-financial sectors. Covering nineteen countries for the period 1987 to 2004, we find that banks are special in that a more competition-oriented regime for merger control increases banks’ stock prices, whereas it decreases those of non-financial firms. Moreover, bank merger targets become more profitable and larger. A major determinant of the positive bank returns, after controlling inter alia for the general quality of institutions and individual bank characteristics, is the opaqueness that characterizes the institutional setup for supervisory bank merger reviews. Thus strengthening competition policy in banking may generate positive externalities in the financial system that offset unintended adverse side effects on efficiency introduced through supervisory policies focusing on prudential considerations and financial stability. Legal arrangements governing competition and supervisory control of bank mergers may therefore have important implications for real activity. JEL Classification: G21, G28, D4.
    Keywords: Specialness of banks, mergers and acquisitions, competition policy, legal institutions, financial regulation.
    Date: 2007–07
  4. By: John Tschirhart; James O'Brien; Michael Moise; Emily Yang
    Abstract: Recent accounting changes, for the first time, permit the use of fair value in the primary financial statements for held-to-maturity (HTM) bank loans. While the use of fair value has historically attracted significant discussion and debate, there is little information in the public domain on how banks would measure fair value or use it in loan management. This study presents and analyzes results from in-depth discussions with seven large internationally-active banks on their fair value use and measurement for HTM commercial loans and commitments. The objectives of the discussions and those of the study are to: identify the extent to which fair value is used for HTM commercial loan facilities and how it is used; describe valuation methodologies used and consider the roles of market price sources and modeling and their relative importance in fair value estimation; consider model validation and price verification; draw conclusions as permitted and suggest areas for future research.
    Date: 2007
  5. By: Gabriel Jiménez; Jose A. Lopez; Jesús Saurina
    Abstract: Since bank credit lines are a major source of corporate funding and liquidity, we examine the determinants of credit line usage with a database of Spanish corporate credit lines. A line's default status is the primary factor driving its usage, which increases as a firm approaches default. Several lender characteristics suggest an important role for bank monitoring in firms' usage decisions. Credit line usage is found to be inversely related to macroeconomic conditions. Overall, while several factors influence corporate credit line usage, our analysis suggests that default and supply-side variables are the most important.
    Keywords: Bank loans ; Credit ; Default (Finance)
    Date: 2007
  6. By: Adam B. Ashcraft; João A. C. Santos
    Abstract: There have been widespread claims that credit derivatives such as the credit default swap (CDS) have lowered the cost of firms' debt financing by creating for investors new hedging opportunities and information. However, these instruments also give banks an opaque means to sever links to their borrowers, thus reducing lender incentives to screen and monitor. In this paper, we evaluate the effect that the onset of CDS trading has on the spreads that underlying firms pay at issue when they seek funding in the corporate bond and syndicated loan markets. Employing matched-sample methods, we find no evidence that the onset of CDS trading affects the cost of debt financing for the average borrower. However, we do find economically significant adverse effects to risky and informationally-opaque firms. It appears that the onset of CDS trading reduces the effectiveness of the lead bank's retained share in resolving any asymmetric information problems that exist between a lead bank and non-lead participants in a loan syndicate. On the plus side, we do find that CDS trading has a small positive effect on spreads at issue for transparent and safe firms, in which the lead bank's share is much less important. Moreover, we document that the benefit of CDS trading on spreads increases once the market becomes sufficiently liquid. In sum, while CDS trading has contributed to the completeness of markets, it has also created new problems by reducing the effectiveness of lead banks' loan shares as a monitoring device - thus creating a need for regulatory intervention.
    Keywords: Credit derivatives ; Swaps (Finance) ; Corporations - Finance
    Date: 2007
  7. By: John P. Harding (University of Connecticut); Xiaozhing Liang (State Street Corporation); Stephen L. Ross (University of Connecticut)
    Abstract: The capital structure and regulation of financial intermediaries is an important topic for practitioners, regulators and academic researchers. In general, theory predicts that firms choose their capital structures by balancing the benefits of debt (e.g., tax and agency benefits) against its costs (e.g., bankruptcy costs). This paper studies the impact and interaction of deposit insurance, capital requirements and tax benefits on a bank's choice of optimal capital structure. Using a contingent claims model to value the firm and its associated claims, we find that there exists an interior optimal capital ratio in the presence of deposit insurance, taxes and a minimum fixed capital standard as long as there is a significant financial burden associated with violating capital requirements. Banks voluntarily choose to maintain capital in excess of the minimum required in order to balance the risks of insolvency (especially to future tax benefits) against the benefits of additional debt. Because our model includes all three contingent claims, our results differ from those of previous studies of the capital structure of banks that have generally found corner solutions (all equity or all debt) to the capital structure problem.
    Date: 2007–07
  8. By: Heng, Stefan; Meyer, Thomas; Stobbe, Antje
    Abstract: Web 2.0 heralds a new era of communication with a massive increase in information supply and where news, opinion and services flow directly from user to user. Financial institutions can take advantage if they stay abreast of this development. However, any Web 2.0 presence of a financial institution must be authentic and consistent with the institution’s brand and corporate culture. To leverage the potential, the need for an immaculate reputation and the right type of brand is becoming ever more important.
    Keywords: information- and communication technology; ICT technology; P2P; Web 2.0; banking; blog; virtual worlds; wiki; lending; e-business; e-commerce; B2C-e-commerce; internet; e-payments
    JEL: G29 E42 O33 E51 O14
    Date: 2007–07–31
  9. By: Illing, Gerhard; Cao, Jin
    Abstract: The paper models the interaction between risk taking in the financial sector and central bank policy. It shows that in the absence of central bank intervention, the incentive of financial intermediaries to free ride on liquidity in good states may result in excessively low liquidity in bad states. In the prevailing mixed-strategy equilibrium, depositors are worse off than if banks would coordinate on more liquid investment. It is shown that public provision of liquidity improves the allocation, even though it encourages more risk taking (less liquid investment) by private banks.
    Keywords: Liquidity Provision; Monetary Policy; Bank Runs
    JEL: E5 G21 G28
    Date: 2007–07
  10. By: W. Scott Frame; Diana Hancock; Wayne Passmore
    Abstract: This paper considers the role of Federal Home Loan Bank (FHLB) advances in stabilizing their commercial bank members' residential mortgage lending activities. Our theoretical model shows that using mortgage-related membership criteria or requiring mortgage-related collateral does not ensure that FHLB advances will be put to use for stabilizing members' financing of housing. Using panel vector autoregression (VAR) techniques, we estimate recent dynamic responses of U.S. bank portfolios to FHLB advance shocks, bank lending shocks, and macroeconomic shocks. Our empirical findings suggest that FHLB advances are just as likely to fund other types of bank credit as to fund single-family mortgages.
    Date: 2007
  11. By: Alexander Muravyev; Dorothea Schäfer; Oleksandr Talavera
    Abstract: This paper studies gender discrimination against entrepreneurs by financial institutions. Based on the Business Environment and Enterprise Performance Survey (BEEPS) that covers firms in several countries of Western Europe as well as in the transition countries of Eastern Europe, our analysis suggests that female-managed firms are less likely to obtain a bank loan compared with male-managed counterparts. In addition, there is some evidence that female entrepreneurs are charged higher interest rates when loan applications are approved. Disaggregation of the sample by country groups suggests that these results are driven by firms in the least financially developed countries of the region.
    Keywords: entrepreneurship, gender, financial constraints
    JEL: G21 J16 L26
    Date: 2007
  12. By: Rocco R. Huang (University of Amsterdam, and European Central Bank. Correspondence address: European Central Bank, DG-R/FIRD, Kaiserstrasse 29, D-60311, Frankfurt am Main, Germany.)
    Abstract: This paper proposes a new methodology to evaluate the economic effect of state-specific policy changes, using bank-branching deregulations in the U.S. as an example. The new method compares economic performance of contiguous counties on opposite sides of state borders, where on one side restrictions on statewide branching were removed relatively earlier, to create a natural “regression discontinuity” setup. The study uses a total of 285 pairs of contiguous counties along 38 segments of such regulation change borders to estimate treatment effects for 23 separate deregulation events. To distinguish real treatment effects from those created by data-snooping and spatial correlations, fictitious placebo deregulations are randomized (permutated) on another 32 segments of non-event borders to establish empirically a statistical table of critical values for the estimator. The method determines that statistically significant growth accelerations can be established at a >90% confidence level in five out of the 23 deregulation events examined. “Hinterland counties” within the still-regulated states, but farther away from the state borders, are used as a second control group to consider and reject the possibility that cross-border spillover of deregulation effects may invalidate the empirical design. JEL Classification: G21, G28, O43.
    Keywords: Banking deregulation, Economic growth, Regression discontinuity.
    Date: 2007–07
  13. By: Beverly Hirtle
    Abstract: This paper examines the relationship between the amount of information disclosed by bank holding companies (BHCs) and their subsequent risk profile and performance. Using data from the annual reports of BHCs with large trading operations, we construct an index of publicly disclosed information about the BHCs? forward-looking estimates of market risk exposure in their trading and market-making activities. The paper then examines the relationship between this index and the subsequent risk and return in both the BHCs? trading activities and the firm overall, as proxied by equity market returns. The key findings are that more disclosure is associated with lower risk, especially idiosyncratic risk, and in turn with higher risk-adjusted returns. These findings suggest that greater disclosure is associated with more efficient risk taking and thus improved risk-return trade-offs, although the direction of causation is unclear.
    Keywords: Bank holding companies ; Risk assessment ; Financial risk management
    Date: 2007
  14. By: François Coppens (National Bank of Belgium, boulevard de Berlaimont 14, BE-1000 Brussels, Belgium.); Fernando González (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.); Gerhard Winkler (Oesterreichische Nationalbank, Otto Wagner Platz 3, A-1090 Vienna, Austria.)
    Abstract: The aims of this paper are twofold: first, we attempt to express the threshold of a single “A” rating as issued by major international rating agencies in terms of annualised probabilities of default. We use data from Standard & Poor’s and Moody’s publicly available rating histories to construct confidence intervals for the level of probability of default to be associated with the single “A” rating. The focus on the single “A” rating level is not accidental, as this is the credit quality level at which the Eurosystem considers financial assets to be eligible collateral for its monetary policy operations. The second aim is to review various existing validation models for the probability of default which enable the analyst to check the ability of credit assessment systems to forecast future default events. Within this context the paper proposes a simple mechanism for the comparison of the performance of major rating agencies and that of other credit assessment systems, such as the internal ratings-based systems of commercial banks under the Basel II regime. This is done to provide a simple validation yardstick to help in the monitoring of the performance of the different credit assessment systems participating in the assessment of eligible collateral underlying Eurosystem monetary policy operations. Contrary to the widely used confidence interval approach, our proposal, based on an interpretation of p-values as frequencies, guarantees a convergence to an ex ante fixed probability of default (PD) value. Given the general characteristics of the problem considered, we consider this simple mechanism to also be applicable in other contexts.
    Date: 2007–07

This issue is ©2007 by Roberto J. Santillán–Salgado. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
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